Why leave all your money in your retirement fund in the stock market? Have you lost money? Do you wish you could diversify? Well, the truth is you can. I will go into some details about how you can use an IRA, but 401K’s, HSAs and other types of funds can be used or rolled over into the proper type of fund. Speak with the company that handles your fund, don’t take no for an answer, they make much less when you self direct your funds.
Generally to self direct your IRA funds, you will use a custodial company. You, or the company, will form an LLC that you invest your retirement money in. Then that LLC is used to invest in whatever you feel is a good investment, in this case, real estate. That is making a long story short, but there are many companies out there that specialize in this. Be sure to check with someone that knows what they are talking about to be sure you have the best set up possible.
After you have your account set up, is is fairly easy to get started.
The next step is to decide how you want to invest. Do you want to be the sole owner? Do you want to pool your money with other investors? There are a few different investment strategies with their own strengths and weaknesses. I’ll go into a couple of them here.
Owning Property Yourself
I like this option for some people, but it really depends on how involved you want to be, and how much money you have to invest.
The obvious advantage is that you have full control over your portfolio, no other investors are involved that can help make decisions. (this is only an advantage if you really know what you are doing!!!) In this scenario, you use your IRA to purchase investment property. Since I specialize in residential rental property, I will use that as an the example.
Let’s say you find a great 2-unit rental property. You have $50,000 in your IRA set aside for this purpose. TO use round numbers, let’s just say the property with closing costs is approximately $50,000. So you now own this property with your IRA funds. The rental income will make up your return. All the monthly rent payment will go back into your IRA. So if this property averages $1,000 income each month after expenses, that’s $12,000 each year you are earning on this investment. That is a 24% yearly return on your investment! Not a bad deal, and we get returns like this on many of our investments! This doesn’t even include what you will earn in appreciation!
The disadvantage to this strategy is you are limited to investing in one, or just a few properties. This can work out great if you get the right properties. Unfortunately, if you have only one or two rentals, and have a bad month or year on a property, it greatly affects your returns. So this strategy is not for everyone.
Investing with other Investors
The biggest strength of this plan is diversification. You have the advantage, and great returns from the last example, but also have your investment spread out over many properties.
Here’s how it works. You find several other investor looking for the same type of investments as yourself. Then you form a holding company, usually an LLC. This LLC will own a larger portfolio of properties. Since many people are pooling their money, you partially own each property, rather than owning 100% of a single property.
So imagine there are 100 properties total. Most of these perform well and earn money. A few of them have a bad month, and create a loss. The strength of the other properties still produces positive income for the entire portfolio. It is the same principle used when investing in stocks. Some will have a loss, but if most have a gain, you still make money.
The biggest disadvantage is that you don’t have 100% control over your portfolio. So you want to make sure that the managing members of the investment group know what they are doing.
I personally believe investing in real estate is a great way to diversify your retirement portfolio. I like the idea of pooling my money with others to own a larger portfolio of properties. Just make sure you understand all the details, and do your research before you buy real estate with you IRA funds!